For Co is a foreign entity that has three types of investments in Australia. It has an Australian permanent establishment (Aust PE) through which For Co carries on a manufacturing business in Australia:

several shareholdings in Australian public companies – these investments amount to 1% of the ordinary shares in each company

a block of flats that it rents out to private tenants – the average value of the block of flats is $25 million.

For Co has $100 million of debt capital, of which $20 million was used to fund the acquisition of the block of flats and $12 million is attributable to Aust PE (it actually raised this debt in Australia through the PE). The remaining debt capital is used in For Co's foreign business. The shares in the Australian public companies were funded by For Co's profits. Aust PE has $5 million of non-debt liabilities and together with the block of flats has generated $2.1 million of debt deductions in Australia.

All loans are at commercial interest rates. For Co, in relation to its Australian investments, is the only entity being tested under the thin capitalisation rules. The test year is the 2014–15 income year. Below is a diagram illustrating these scenarios and the relevant financial information for Aust PE.

Table: Aust PE's assets and liabilities for year ending 30 June 2015 (average values using opening and closing balances method)

Assets

$m

Liabilities

$m

Current assets

Building and plant

4

13

Debt capital

Non-debt liabilities

12

5

17

17

Assume For Co’s has statement worldwide debt of $100 million and statement worldwide equity of $40 million.

For Co has $2.1 million worth of debt deductions in the 2014–15 income year and fails the debt deduction de-minimus test. Because it is an inward investor, it cannot apply the asset de-minimus test.

Step 1: Calculate For Co's adjusted average debt

Worksheet 1: For Co's step 1

Steps

$m

Step 1.1: The average value of all for Co's debt capital that gives rise to debt deductions is $32m ($12m attributable to the Australian permanent establishment and $20m funding the Australian block of flats). The debt capital used by For Co on its foreign business would not give rise to deductible expenses in Australia

Average debt capital

(A)

32

Step 1.2: For Co does not have any associate entity debt attributable to its Australian permanent establishment

Average associate entity debt

(B)

0

Step 1.3: For Co does not have any cost-free debt capital

Average cost-free debt capital

(C)

0

Step 1.4: For Co's adjusted average debt is $32m

Adjusted average debt (A–B+C)

=

32

For Co's adjusted average debt is $32 million. This is now compared to For Co's maximum allowable debt, which is the greater of its:

safe harbour debt amount

arm's length debt amount

worldwide gearing debt amount.

For Co can calculate these amounts in any order it chooses and does not necessarily have to calculate all amounts.

Step 2: Calculate For Co's safe harbour debt amount

Worksheet 2: For Co's step 2

Steps

$m

Step 2.1: The average value of For Co's Australian assets is $42m (Aust PE's assets of $17m and the block of flats worth $25m). The shares held in the Australian public companies are not Australian assets because they do not produce any assessable income

Average assets

(D)

42

Step 2.1A: For Co does not have any excluded equity interests

Average excluded equity interest

(JJ)

0

Step 2.2: For Co does not have any associate entity debt attributable to its Australian permanent establishment

Average associate entity debt (from B on worksheet 1)

(B)

0

Step 2.3: For Co does not have any associate entity equity attributable to its Australian permanent establishment

Average associate entity equity

(E)

0

Step 2.4: The average value of For Co's non-debt liabilities is the $5m that have arisen because of Aust PE

Average non-debt liabilities

(F)

5

Step 2.5: Reduce For Co's average assets by the amounts at JJ, B, E & F

D – JJ – B – E – F

(G)

37

Step 2.6: Multiply the result at G by 3/5

G x 3/5

(H)

22.2

Step 2.7: For Co does not have any associate entities and so does not have an associate entity excess amount

Average associate entity excess amount

(J)

0

Step 2.8: For Co's safe harbour debt amount is calculated by adding the amounts at H and J

Safe harbour debt amount = (H + J)

=

22.2

For Co's safe harbour debt amount is $22.2 million. For Co's adjusted average debt is more than this amount. For Co can calculate an alternative amount under the arm's length debt amount test or the worldwide gearing debt amount test (though these may not be higher than the safe harbour debt amount) or can choose to use the safe harbour debt amount as its maximum allowable debt.

Step 3: Calculate For Co's arm's length debt amount

For the purposes of this exercise, assume For Co chooses not to calculate an arm's length debt amount.

Step 4: Calculate For Co's worldwide gearing debt amount

An entity cannot use the worldwide gearing debt test unless the result of the following formula is greater than 0.5:

Average Australian assets of the entity / Statement worldwide assets of the entity for the income year

This threshold requires that the entity’s Australian assets represent no more than 50 per cent of the consolidated group’s worldwide assets.

For Co’s.average Australian assets for the year are $17m and statement worldwide assets is $140m. The result of applying the above formula is 0.12, therefore Aust Co is eligible to apply the new worldwide gearing debt test.

Worksheet 4: For Co's step 4

Steps

Step 4.1: For Co's worldwide debt is $100m

Worldwide debt

(Z)

$100m

Step 4.2: For Co's worldwide equity is $40m

Worldwide equity

(AA)

$40m

Step 4.3: For Co's worldwide gearing ratio is calculated by dividing its worldwide debt by its worldwide equity

ZAA

(BB)

2.5

Step 4.4: Insert the amount of BB at CC

BB

(CC)

2.5

Step 4.5: Add 1 (one) to the amount at CC

CC + 1

(DD)

3.5

Step 4.6: Divide the amount at CC by the amount at DD

CC / DD

(EE)

.7148587

Step 4.7: The gearing ratio is applied to For Co's net assets G from Worksheet 2

EE $37m

(FF)

$26.44

Step 4.8: The average value of For Co's associate entity excess amount is $0 as there are no associated entities

(GG)

$0

Step 4.9: For Co's worldwide gearing debt amount is calculated by adding the amounts at FF and GG

Worldwide gearing debt amountFF + GG

$26,440,000

Step 5: Calculate For Co's debt deductions disallowed

For Co's maximum allowable debt is $26.44 million (the worldwide gearing debt amount). As For Co's adjusted average debt ($32 million) is more than its maximum allowable debt, a proportion of its debt deductions will be disallowed.

For Co's debt deductions are $2.1 million.

Worksheet 5: For Co's step 5

Steps

Step 5.1: For Co's average debt is $32m and its maximum allowable debt is $26.44

Excess debt($32m – $26.44m)

(X)

$5.56m

Step 5.2: For Co's average debt capital is $32m; that is only $32m gives rise to debt deductions

Average debt capital

(Y)

$32m

Step 5.3: Divide the amount at X by the amount at Y

X / Y($5.56m / $32m)

(Z)

0.17375

Step 5.4: Calculate For Co's debt deductions for the income year

Debt deductions

(AA)

$2.1m

Step 5.5: Multiply the amount at Z by the amount at AA. This is the total debt deductions disallowed to For Co

Z x AA(0.17375 x $2.1m)

=

$364,875

For Co cannot deduct $364,875 of its debt deductions.

The steps a non-ADI general inward investor takes to calculate if they have met the thin capitalisation rules and, if they have not, the amount of debt deductions disallowed.

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